The Flat Rate VAT Scheme: Does It Suit Contractors?

The Flat Rate VAT Scheme and whether it suits contractors

Most limited company contractors who are VAT-registered will, at some point, weigh up whether to use HMRC's VAT Flat Rate Scheme (FRS) instead of standard VAT accounting. It is a genuine simplification for some small businesses, but it does not suit every contractor's situation. This guide explains how the scheme works, what HMRC's rules actually say, and the questions worth raising with an accountant before applying.

This is a general explainer, not advice on your own VAT position. Whether the Flat Rate Scheme is right for your limited company depends on your specific costs, sector and turnover, so speak to a contractor accountant before deciding.

What the Flat Rate Scheme actually is

The VAT Flat Rate Scheme is an HMRC simplification regime. Instead of tracking VAT on every sale and every purchase and reclaiming input VAT in the usual way, a business pays HMRC a fixed percentage of its VAT-inclusive turnover.[1][2] That percentage is set by HMRC according to the trade sector the business operates in, and it is applied to turnover that already includes VAT, not to the net figure.[2][4]

The appeal is administrative. There is less record-keeping, fewer decisions to make about what counts as reclaimable input VAT, and a simpler VAT return each period. HMRC's own framing is that this is a scheme "for small businesses", and the official rulebook is VAT Notice 733: Flat Rate Scheme for small businesses.[4]

Who can join

HMRC says a business may be able to join the scheme if its VAT turnover is £150,000 or less, excluding VAT.[1][4] To join, the limited company must already be registered for VAT, and it must apply to HMRC. Businesses already VAT-registered use form VAT600FRS to apply.[1][15]

If the business covers more than one trade sector, HMRC's application guidance is clear: use the business type that generates the highest proportion of turnover, rather than picking whichever rate looks lowest.[15] For a contractor operating through a personal service company, that generally means identifying the single sector description that best fits the bulk of the contract work, which is not always obvious once for umbrella-style consultancy, IT contracting, or management consultancy categories are compared side by side.

How the flat rate is worked out

The flat rate percentage varies by sector. HMRC publishes an A to Z list of sectors and their associated percentages in its internal manual, FRS7200 - Trade Sectors, which is the reference point for finding the applicable rate.[12]

The mechanics are straightforward once the rate is known. HMRC's guidance on working out your flat rate confirms that VAT due is calculated by multiplying the flat rate percentage by VAT-inclusive turnover, not net turnover.[2] The business then keeps the difference between what it charged customers in VAT and what it actually pays over to HMRC.[1]

The input VAT trade-off

The most important mechanical point for contractors is what the scheme gives up in exchange for simplicity: HMRC's guidance says a business on the Flat Rate Scheme cannot usually reclaim VAT on its purchases.[1] There is one notable exception. Input VAT can still be reclaimed on certain capital assets costing more than £2,000, subject to the scheme's specific conditions.[1]

This is where the scheme suits some contractors far better than others. A contractor with genuinely low overheads, working largely from a laptop with modest running costs, might find the flat rate percentage plus the loss of general input VAT recovery works out favourably compared with standard VAT accounting. A contractor with significant reclaimable costs, perhaps larger equipment purchases below the £2,000 capital asset threshold, travel-heavy expenses, or other substantial VATable overheads, may find that giving up input VAT recovery outweighs the administrative saving.

There is no single answer that applies across the board. It depends on the actual mix of income and expenditure in the limited company, which is exactly the kind of calculation a contractor accountant is best placed to run.

Where this sits alongside IR35

It is worth being clear that the Flat Rate Scheme is a VAT administration choice. It has no bearing on a contract's IR35 status. Whether a limited company's engagement is inside or outside IR35 depends on the working practices agreed with the end client, matters like substitution and control, and is set out in the client's Status Determination Statement. A VAT scheme election does not feed into that assessment in either direction, and nothing in HMRC's Flat Rate Scheme guidance touches on employment status at all.[1][4]

Contractors weighing up VAT scheme options alongside broader limited company running costs may also find it useful to compare current day-rate benchmarks and to browse outside-IR35 contracts when assessing overall contract economics.

Practical steps before applying

• Check current VAT turnover against the £150,000 threshold, excluding VAT, using HMRC's overview guidance.[1][4]
• Identify the correct trade sector from HMRC's A to Z list, using the highest-turnover business type if more than one applies.[12][15]
• Model the flat rate percentage against typical VAT-inclusive turnover and compare it with likely input VAT recoverable under standard accounting.
• Apply via form VAT600FRS if already VAT-registered, following HMRC's application guidance.[1][15]
• Review the decision periodically, since turnover, sector mix and expenditure patterns can change as contracts change.

None of these steps replace a proper conversation with a qualified accountant who can look at the specific numbers for a given limited company. HMRC's guidance sets out the mechanics, but it makes no contractor-specific recommendation, and neither does this article.

This platform does not determine, verify, or warrant IR35 status; the SDS is the client's legal responsibility. Contractors should take their own advice and consider IR35 insurance.